A Damning Report

HIH collapsed in March 2001, with estimated debts of up to $5.3 billion. Facing growing pressure from shareholders, creditors and policyholders alike, the government set up a Royal Commission to examine whether decisions or actions of directors, officers or associated advisers contributed to the failure or whether any of those involved were involved in any undesirable corporate governance practices. The commission was also charged with examining the adequacy and appropriateness of arrangements for the regulation and prudential supervision of general insurance at Commonwealth, state and territory level. Justice Owen delivered his report in April 2003, recommending among other things changes to the Corporations Act that could make middle managers, contractors and possibly advisers legally liable in the event of a corporate collapse.

The report prompted a wave of law reform and a strengthening of the corporate governance framework through the ASX Governance Council's "comply or explain" approach to its new best practice guidelines. And the ramifications of the collapse contain important lessons for CIOs across the spectrum of Australian industry.

"The Royal Commission described the various pathologies of a chronically mismanaged group of companies as a massive post mortem," Dellit says. "Some of that post mortem deals with the sustained inadequacies of the IT systems intended to support the various business lines of the HIH group of companies. Apparently, both the HIH and FAI IT systems at various points, or for sustained periods, were unable to generate the financial data and calculations necessary for the effective functioning of a diversified insurance group."

In fact Justice Owen found three areas of deficiency in management information: in HIH's electronic financial systems, in its reconciliation of ledger and bank accounts, and in its budgets. "The importance of maintaining information and accounting systems capable of producing and retaining accurate financial information is recognised in the Corporations Act 2000," he noted. "Under the legislation in force prior to its demise, HIH was obliged to maintain financial records that correctly recorded and explained its financial position and performance and enabled true and fair financial statements to be prepared and audited."

Unfortunately, there were problems in HIH's reconciliation of ledger and bank accounts extending over a long period, with senior personnel in the financial services division acknowledging significant and ongoing problems with data reconciliation resulting from system problems. The problems were so profound that even after considerable effort in 2000 to rectify the situation, numbers of accounts remained unreconciled at the date of appointment of provisional liquidators.

"It is extraordinary that HIH was not able to carry out a comprehensive reconciliation of all its balance sheet ledger accounts between late 1996 and March 2000," Justice Owen said. "Given the effect that unreconciled accounts may have had on HIH's internal and external financial reporting, it was not enough simply to complete material reconciliations."

HIH also consistently failed to meet budget - a reflection of a serious breakdown in its internal financial controls.

And thanks largely to a long history of M&A activity, at the time of its collapse HIH operated numerous insurance and accounting systems to manage its insurance business. They included an Oracle system for general ledger, purchased after the CIC take-over; the Aegis system acquired by HIH during the take-over of FAI and used to hold policy details and claims histories for FAI business; the liability and indemnity recording system contained the data for a number of HIH portfolios, including professional indemnity, public liability, trade credit and builders warranty; and finally, the GEN+ system developed by HIH to bring together the existing systems in order to provide greater functionality and to meet year 2000 compliance requirements.

The introduction of GEN+ proved extremely problematic. It led to numerous problems across the organisation which continued right through until 2000 when a February internal audit report noted a significant number of unreconciled bank accounts across the group that related to the implementation of GEN+.

Justice Owen found despite efforts to resolve the problems and the introduction of manual procedures to produce accurate financial information, HIH's ability to operate effective credit control and debtor management processes was impaired as a result of the problems with GEN+. Further, the manual processing was expensive and provided the temptation to capitalise costs that should have been expensed. He also found problems in HIH's reconciliation of ledger and bank accounts extending over a long period, and a continuing failure to meet budgetary targets that indicated fundamental problems in the business strategy or underlying performance of the business.